Why is Creston PLC interesting?

• Lowest valuation among 14 public peers.  Selling for 8x forward EPS and 7x FCF despite no debt.  NOTE ALL DOLLAR AMOUNTS SHOULD BE IN UK DOLLARS.

• Track record of significant free cash flow generation over past decade and stable competitive position.  Solid balance sheet.

• FCF/sales has averaged 12%-15% and company has generated £87mm of FCF, or 150% of current Enterprise Value, in past 10 years.
• Takeout candidate.  Havas, a much larger publicly traded peer (€2.4bn market cap) bought 6% of Creston PLC in the open market in mid-2012.  Management would not respond when asked why.  Havas has a long history of buying smaller ad agencies.  Havas sells for valuation metrics 2x higher than Creston and Creston has corporate expenses = 25% of profits such that one would think an acquisition would be highly accretive.
• Dividend yield >3.5% and has increased each year since 2008 despite delivering and no net debt.
• Management Change.  Long-time CFO / COO becomes the new CEO in March 2014.  CEO is older and was expected to step down.

 

Creston PLC (CRE LN) is a thinly traded UK microcap that operates a much smaller version of ad agency rollups a la Omnicom, Interpublic, Publicis, among others. 

Like most conglomerate ad agencies, Creston operates a low capex business model, with mostly variable costs in the form of labor, leases and other G&A.  Operating margins tend to run in the 13% to 18% range.  Creston's margins have eroded since 2008 and were hurt more recently by the 1H/13 loss of Sanofi, a large long-time client.  Margins appear to be stable now and management is rightsizing the business by combining some real estate sites. Creston currently sells for 8x EPS with a debt free balance sheet.  Peers sells for 12-16x EPS.  Creston has landed in the temporary penalty box due to soft performance stemming from a large client loss, poor margin performance since 2008, and five years of sluggish UK ad spend.  We believe all three of these headwinds/factors are set to abate in the next year and interestingly, Havas, a much larger publicly traded peer (€2.4bn market cap) bought 6% of Creston PLC in the open market in mid-2012.  Management would not respond when asked why.  Havas has a long history of buying smaller ad agencies.  Havas sells for valuation metrics 2x higher than Creston and Creston has corporate expenses = 25% of profits such that one would think an acquisition would be highly accretive.  Creston also pays a 3.8% dividend yield which is well covered and has increased each year since 2008. 

 

Creston was formed in 2001 by CEO Don Elgie and CFO/COO Barrie Brien and trades on the London Stock Exchange.  Management owns 4%.  All employees and directors own 15%. With 817 employees, Creston is a holding company that owns ~22 small advertising, public relations, and marketing service agencies, mostly in the UK.  The company was built via acquisition from 2001-2006.  Acquisitions were financed via debt, equity and earn-outs.  Post 2006, Creston began to slow down its acquisition pace, conducting only 3 small acquisitions from 2010-2012 and one sizable divestiture. 

 

Creston operates three business segments as shown below:

 

1) Communications: 50% of earnings.  11 agencies focused largely on traditional media

2) Health: 33% of earnings.  Focused on healthcare companies.  Half of revenues come from the U.S.

3) Insight: 17% of earnings.  Consists of 2 agencies, largely market research-oriented

 

Revenues are 2/3rds UK, 15% U.S. and 15% rest of world.  Approximately 50% of Creston's revenue comes from top 20 clients.  Importantly, the company's average client tenure is 10 years, indicating a fairly sticky customer base. 

 

Also important is Creston's significant progress in the digital channel.  Advertising is increasingly moving to non-traditional mediums and companies (clients) are willing to pay for expertise around all things digital.  Creston derives over 50% of its sales from digital initiatives and appears to be somewhat of an early mover in this area. 

Acquisition by Havas (which already owns 6% of Creston PLC shares).

Stabilization of margins and revenues post the loss of Sanofi.

Resumption of growth of UK-based advertisting market.

Continued penetration of digital channel.